CAPITAL-MARKET FRICTIONS AND THE ROLE OF INTERNAL CAPITAL-MARKETS IN BANKING

The extent to which banking firms face external financing costs when f unding new loans has important implications for the role of banks in t he corporate capital acquisition process, for the effectiveness of mon etary policy and for the impact of capital requirements. We investigat e this issue by examining the cash-flow sensitivity of loan growth at bank holding companies, and by examining the extent to which holding c ompanies establish an internal capital market to allocate capital amon g their various subsidiaries. Overall, we find that loan growth at sub sidiary banks is more sensitive to the holding company's cash flow and capital position than to the bank's own cash flow and capital. Moreov er, we find that bank loan growth is negatively correlated with loan g rowth among the other subsidiaries within the holding company. Overall , this evidence suggests that bank holding companies establish interna l capital markets to allocate scarce capital among their various subsi diaries.